What you need to know about the latest UAE economic substance regulations

The UAE cabinet has issued the Cabinet Decision No. 57/2020, dated 10 August 2020 (“Regulations”) which repeals and replaces the Cabinet Resolution No. 31 of 2019 concerning economic substance regulations. The cabinet decision was followed by the release of the Ministerial Decision No. 100 of 2020, dated 19 August 2020 constituting the supplementary guidance for the new regulations.

Earlier the Economic Substance Regulations (Cabinet of Ministers Resolution No. 31 of 2019) had been issued on 30 April 2019. Thereafter, Guidance on the application of the Regulations was released on 11 September 2019 (Ministerial Decision No. 215 of 2019), and Cabinet Decision No. 58/2019 was issued listing the Regulatory Authorities tasked with the administration and enforcement of the Regulations.

The Economic substance regulations have been introduced by UAE government in response to an assessment by the European Union Code of Conduct Group on Business Taxation in the UAE and as part of the UAE’s commitment as a member of the ‘Organization for Economic Co-operation and Development’ (OECD) framework. The latest amended regulations introduce key changes to the existing law and are in effect from the financial years commencing from 1 January 2019 onwards.

The latest regulations have assigned responsibilities to both the Federal Tax Authority (FTA ) and the Regulatory Authorities. However, the role of the Regulatory Authorities is now more limited to collecting and reviewing the ESR Notifications and Reports for accuracy and completeness and reporting to the FTA as per requirements. 

Economic substance test: 

The Regulations prescribe for an ‘Economic Substance Test’ (‘ESR Test’) which requires all UAE onshore, off shore and free zone companies carrying out any of the defined ‘Relevant Activities’ as listed below to maintain and demonstrate an adequate ‘economic presence’ in the UAE relative to the activities they undertake. The ESR Test requires the dual requirements to be satisfied to fall under the Regulations, viz a viz, conducting a ‘Relevant Activity’ and earning income in relation to the relevant activity.

Companies are required to submit an annual notification form to their Regulatory Authority, and submit an ‘Economic Substance Report’ to the same Regulatory body within 12 months of the end of the financial year. For the financial year ending on 31 December 2019 the deadline for the submission of the report will fall on 31 December 2020.

Failure to comply with the Regulations can result in penalties as well as other administrative sanctions such as the suspension, revocation or non-renewal of the entity’s trade license or permit. 

Relevant activities:

The “relevant activities” of the Regulations include: 

• Banking
• Insurance Business
• Investment fund management
• Leasing – financing business
• Headquarters
• Shipping
• Business with holding companies
• Intellectual property “IP”
• Distribution and service centre

Excludes:

An entity is not obliged to pass the “economic substance test” and submit an “economic substance report” for a financial period in which it has not generated income from a “relevant activity” or fulfils the conditions for exemption set out below.

However, it is important to note that the exempted entities are still obliged to file a “notification” with the Regulatory Authority and provide sufficient evidence to justify their exemption status.

The regulations explicitly exclude the following entities:

• Foreign tax entities
• Companies that are wholly owned by UAE citizens or UAE residents who are not part of an MNC group and only engage in domestic activities, the term “UAE resident” refers to either UAE citizens or persons with a UAE residence visa residing in the UAE.
• Establishments of foreign companies in the United Arab Emirates whose entire relevant income is taxed under the jurisdiction of the parent company
• An investment fund and its SPV / associated company;
• Branch of a foreign company taxed on all relevant income in a foreign jurisdiction;
• Any other licensee on the instructions of the Ministry of Finance